COWLES FOUNDATION FOR RESEARCH IN ECONOMICS
AT YALE UNIVERSITY

Box 208281
New Haven, CT 06520-8281

COWLES FOUNDATION DISCUSSION PAPER NO. 826R

"Inefficient Dynamic Portfolio Strategies
or How to Throw Away a Million Dollars in the Stock Market"

Philip H. Dybvig

March 1987
Revised January 1988

A number of portfolio strategies followed by practitioners are dominated because they are incompletely diversified over time. The Payoff Distribution Pricing Model is used to compute the cost of following undiversified strategies. Simple numerical examples illustrate the technique, and computer-generated examples provide realistic estimates of the cost of some typical policies using reasonable parameter values. The cost can be substantial and should not be ignored by practitioners. A section on generalizations shows how to extend the analysis to term structure models and other general models of returns.